The liquidity coverage ratio LCR refers to the proportion of highly liquid assets that financial institutions must hold to ensure that they can meet their short-term obligations and ride out any disruptions in the market. It is mandated by international banking agreements known as the Basel Accords. The BCBS is a group of 45 representatives from major global financial centers. One of its roles is to set standards that will maintain the solvency of the worldwide banking system no matter what stresses the system encounters.
As part of that, banks are required to hold enough high-quality liquid assets to fund cash outflows for 30 days. High-quality liquid assets include only those that can be converted easily and quickly into cash. The three categories of liquid assets with decreasing levels of quality are level 1, level 2A, and level 2B.
Thirty days was chosen in the belief that in the event of a serious a financial crisis, governments and central banks , such as the Federal Reserve Bank in the U. Having a day cushion of cash would theoretically enable the banks to survive a bank run until that happened.
Level 1 assets include Federal Reserve bank balances, foreign resources that can be withdrawn quickly, securities issued or guaranteed by specific sovereign entities, and U. Level 2A assets include securities issued or guaranteed by specific multilateral development banks or sovereign entities, and securities issued by U. Level 2B assets include publicly traded common stock and investment-grade corporate debt securities issued by nonfinancial sector corporations.
:max_bytes(150000):strip_icc()/liquidity-coverage-ratio_final_2-fcb28a55d81d4ec8a679dbc8c93a9f24.jpg "Adult Guide in Basel")
Calculating LCR is as follows:. The LCR was proposed in , followed by revisions and final approval in Liquidity ratios of various kinds are used not only in bank regulation but throughout the business and financial world, typically as a measure of a company's ability to pay off its current debt obligations without raising external capital.
